Mail Bag: How Would You Measure Financial Success?
What defines financial success? Each of you probably has your own answer, but here’s how I think about it.
If someone asked you to define financial success how would you do it? How should we measure ourselves if we want to build wealth?
If you’re looking for my personal answer, I would consider someone financially successful when they can independently generate enough money to fund the lifestyle they require while retaining control over their time. For some people, this is $20,000 a year, for others it is $20 million a year. It’s the only definition that takes into account the true purpose of money, which is to be a tool to accomplish whatever it is you want to do, while simultaneously measuring it against the life you have to give up to attain it (which is what selling your time for a paycheck is, after all; selling part of your life).
If you’re looking for a numerical, mathematical number, your best bet would be to examine both the absolute and relative income of various demographic groups in the United States and measure your progress against them as a benchmark. Specifically:
- A middle class family in the United States earns between $2,895 and $4,336 every month before taxes, which requires both spouses to work in most cases. That is the center quintile based on the most recent tri-annual Survey of Consumer Finances from the Federal Reserve. If you make less than that, your goal should be to get into the middle class.
- To be a member of what the New York Times has called the “truly affluent”, you must earn $20,832 per month before taxes. This is the group that, if you are financially sophisticated and know how to allocate capital, it can be effortless to build wealth and enjoy the nicer things in the world. You can drive a new luxury car every few years, take the occasional trip to a top-tier department store and overhaul your wardrobe, vacation in the South of France during the summer; all while still shoving money into accounts that throw off new streams of passive income.1
- To be a member of the top 1%, you must earn at least $32,334 per month before taxes. For the typical household in this bracket, roughly half of the income is generated through selling time (e.g., a medical doctor on salary at the local hospital), one fourth is generated from dividends, interest, rents, and other investment income, and one fourth is generated from profits on operating companies such as a small business held by the family. This is after tax shelters, such as 401(k) or SEP-IRA funding, so the real number would be a bit higher to adjust for the artificially low AGI. The real wealth compounding would be higher, too, since a lot of the income doesn’t show up at all (e.g., if you own $1,000,000 worth of Berkshire Hathaway, your cut of the after-tax profits is $60,000 per annum but none of it appears anywhere on your personal financial statements due to how the tax laws are written in the United States; likewise, Ross Perot once famously generated hundreds of millions of dollars in interest income from tax-free municipal bonds and none of it appeared on his tax filings because it was exempt). If life were a video game, this would be Level 99.
- To be a member of what one of the best academic experts on wealth in the United States has called the “glittering rich”, you’d need to earn $250,000 per month before taxes. This corresponds with a net worth in the range of $30 million or so, which is considered “ultra-high net worth” in the private banking world.
There are only two higher categories – the 15,000 families that control a disproportionate percentage of the assets in the United States (which requires around $850,000 per month in pre-tax income) and those on the Forbes 400 list, where the numbers cease to have any practical meaning but very few people are going to notice a difference past the glittering rich category other than ego and, perhaps, the ability to make each of your grandchildren super-rich as well. As a matter of fact, there is now a good body of academic evidence that for practically everyone, owning 300 expensive cars won’t make you any happier than someone who owns 3 expensive cars. The actual figure is surprising low, too. The most famous study on the topic out of Princeton found that personal happiness topped out at $6,250 pre-tax per month, while another source claims the ideal, theoretical figure for most people to live the way they want is $13,417 per month. Turns out most people just want a nice car, a decent house, a few good clothes, and some spending money in their pocket.
1 In my own anecdotal experience, and dealing with the countless people I have over the years who show me their finances, there seems to be an intellectual dividing line here. A significant percentage of the households that make it into this group still have bad money habits from growing up with poor financial influences and are one paycheck away from ruin. They are convinced that they can’t live like they want to live because of any number of excuses (e.g., the cost of living in my city is too high, I can’t keep my kids in the same private school as my boss who is making ten times what I make, etc.) It’s nonsense. If you make it to this point and you don’t have a debt-free balance sheet with at least seven or eight figures by retirement, it was because you didn’t know what you were doing. The management failure is yours and yours alone.
In the aftermath of the Great Recession, there were too many stories to count in major news publications profiling “fallen” executives, such as a former Vice President for General Electric, who found his family surviving on Federal benefits and barely scraping by because they could no longer afford the huge mortgage, private tuition at university for multiple kids, and toys they had put on credit during the boom time. Then, when times got tough, instead of cutting his lifestyle, he raided the 401(k) accounts until almost nothing was left. That’s just stupidity. Sad? Yes. But stupid nonetheless. It was a pointless tragedy caused by foolishness not some injustice in the universe.